Principal Review: A 79-Year-Old, a Seven-Year Lockup, and a $15,000 Loan
Rep Dana Whitfield submits for principal approval a $120,000 purchase of units in a non-traded DPP for client Harold Nunn, age 79. The program has a seven-year holding period, limited redemption at a 5% discount to offering price, and a 6.25% distribution rate. Nunn's liquid net worth is $310,000; his income is $38,000 in Social Security plus a $9,000 pension, and the $120,000 comes from a CD ladder he draws on for living expenses. Whitfield's note reads only: 'Wants more income. Signed suitability form.' A branch assistant mentions that Nunn declined long-term care coverage two months ago because of the cost. You also learn Whitfield entered the order the same afternoon instead of holding it for pre-approval, as the WSPs require for DPPs, and that Nunn recently lent Whitfield $15,000, disclosed in the outside-activity log but never approved.
1. Should the principal approve the $120,000 purchase? Walk through the suitability analysis and state what you would approve instead, if anything.
Read the worked answer
Do not approve as submitted. Work the numbers before the narrative.
- Concentration: $120,000 is 38.7% of $310,000 liquid net worth in a single illiquid program.
- Liquidity: the money is coming from the CD ladder that funds his spending; a seven-year hold with redemption at a 5% discount converts his cash reserve into an asset he cannot tap without penalty.
- Time horizon and need: age 79 with $47,000 of fixed income means the portfolio's job is to fund withdrawals, not to maximize distribution rate.
- Behavioral evidence: declining long-term care coverage for cost signals that liquidity, not yield, is the binding constraint. The rep's note ignores that entirely.
- Product economics: the 6.25% distribution is not a return; part of it may be a return of capital, so the client could be consuming principal while believing he is living off income.
The suitability form being signed is not the test; the recommendation must be suitable for this customer. A defensible alternative is a materially smaller allocation - roughly 10-15% of liquid net worth ($30,000-$45,000) funded from assets he does not spend - or no DPP at all. Whatever is approved, document the reduced amount, the funding source, and the client's acknowledgment that the position is illiquid.
2. What supervisory problems exist beyond suitability, and how should each be handled? Include the order-entry timing and the loan.
Read the worked answer
Two independent problems, both escalating.
1. Order entered before principal approval. The WSPs require pre-approval for DPP orders. The principal cannot retroactively bless the ticket; that converts a supervisory system into paperwork. The firm should treat it as a supervisory failure, review whether the trade settled or can still be cancelled, and document the review. A pattern of after-the-fact approvals across the branch is a systems failure, not an individual lapse.
2. The $15,000 loan from the customer. Borrowing from a customer is prohibited unless the arrangement falls within a narrow exception (e.g., a firm's own lending program, a financial institution on normal terms, an immediate family member) and the firm gives written approval. A personal $15,000 loan from a 79-year-old client to her registered rep is not within any exception. Handle it as:
- immediate escalation to compliance and legal;
- unwind or document repayment on a schedule acceptable to legal;
- assess whether the loan influenced the recommendation (a rep owing money to the person he is advising has an obvious conflict);
- consider whether a disclosure event has been triggered and whether heightened supervision is warranted.
The judgment: the loan is not a footnote to the suitability question. It is the reason to distrust the rep's characterization of the client's objectives.
3. The trade has already been accepted by the sponsor. What remediation steps should the principal take, and in what order?
Read the worked answer
Sequence matters because the client's money and the client's trust are both at stake.
- Stop further activity on the account and place the rep on heightened supervision pending review.
- Determine settlement status. If the sponsor has not yet accepted, cancel. If accepted but not closed, request rescission. If closed, evaluate rescission or a partial reduction and get legal involved before contacting the client.
- Contact the client directly, without the rep present. Confirm objectives, liquidity needs, the role of the CD ladder, and what she was told about the distribution rate. Consider involving a trusted contact or family member if the client consents or if financial exploitation is suspected.
- Document contemporaneously - the review, the numbers, the client conversation, and the decision rationale. A reconstructed file written after a complaint is worth very little.
- File the complaint/dispute record if the client raises one, and report through the firm's required channels; do not let the record disappear because the matter was resolved quickly.
- Feed the finding back into branch supervision: pre-approval enforcement, senior-investor review triggers, and a loan-prohibition attestation.
The point the exam is testing is that remediation is not 'unwind and move on.' It includes fixing the control that allowed the sale to be entered.